NIALL FERGUSON: Okay, I Admit It—Paul Krugman Was Right

On Friday in Davos, I interviewed Harvard professor Niall Ferguson, who has been very vocal in recent years about how the world is careening down an unsustainable path.

Unless countries get control of their ballooning debts, Ferguson has argued, we will be headed for crisis after crisis. And Ferguson remains convinced that Europe is on the edge of disaster.

But Professor Ferguson’s take on the United States has changed notably over the past year. He still thinks the U.S. budget deficit is unsustainable and that our entitlement programs will ultimately have to be cut. But he has changed his mind about the U.S.’s ability to sustain its huge debt load.

In one key way, Professor Ferguson now concedes, his adversary Paul Krugman has been right: The U.S. can carry a much-higher debt-to-GDP ratio than he thought. In fact, Ferguson now says, even his Harvard colleague Ken Rogoff, who wrote a seminal book about debt crisis called This Time It’s Different, may be too pessimistic about the United States.

But Europe, Professor Ferguson says, is still screwed.

BLODGET: Welcome, Professor Ferguson! Great to see you again. So, where are we? You have been very concerned about the huge debt load the world’s building up, but so far we seem to be tolerating it.

FERGUSON: Well, I think that’s true of the United States. I don’t think it’s true of Europe. I think the debt crisis in Europe is unresolved and may be very close to going critical. The Greek default may be a matter of days away. And we heard from Angela Merkel, a speech at the beginning of the conference that really filled me with foreboding, because it suggests that she doesn’t get—or doesn’t want to admit—that the only way out of this short of disbanding the single currency is for substantial commitment of resources to the peripheral economies. All she’s offering is austerity, austerity, and more austerity. And that just isn’t going to work. So I think the debt crisis in Europe is an even bigger problem than it was 12 months ago.

BLODGET: And the U.S.?

FERGUSON: I think the U.S. is illustrating a curious paradox—or maybe it’s just the reverse side of the Euro—the worse in Europe, the better in the U.S. The money that has fled the European debt markets has largely gone into Treasuries, and that has given the U.S. a stay of execution. The debt problem in the U.S. is just as bad as ever, but the pressure on the politicians to do something about it has in fact been eased by the Eurozone crisis.

BLODGET: We’ll come back to the U.S. In Europe, what people are saying here [in Davos] is that they are surprised at how much of an impact the latest kicking-the-can-down-the-road has had. All the interest rates are coming down. People seem optimistic that maybe Greece defaults but no big deal, they’re not going to leave the Euro. Why are you still so concerned?

FERGUSON: Well, I am not surprised that finally an act of policy by the ECB has had a good effect. What [new ECB head] Mario Draghi has done is what [old ECB head] Trichet should have done some considerable time ago—and that is more aggressive expansion of the ECB balance sheet. That has solved the liquidity problem for the European banks. And that, in turn, has eased the pressure on some of the sovereigns. Not Portugal, though. And Portugal is a flashing red light telling you that you can’t just confine this to Greece. Whatever happens to Greece by logical extension will happen to Portugal. And believe me, what happens to Portugal by logical extension will happen to someone else. And if it’s Spain or Italy, that’s a heck of a problem. So I think the monetary side of the story is a definite improvement. I think we’ll see more of that. I think we can expect very aggressive policy by Draghi, though the rhetoric won’t be aggressive. The ECB cannot signal how aggressive it’s being because it has to talk, as somebody put it, in German, even while it’s behaving Italian. And that means that the impact is slightly muted. It’s not like Ben Bernanke, who can tell you exactly what he’s going to do for the next four years—guaranteed easy money as far as the eye can see. Draghi has to talk in a slightly more muted way. But if you turn your attention to the solvency issues, both on bank balance sheets and in sovereign budgets it’s horrible. So, I’m pretty sure that the Davos mood of “Oh, it’s all going to be fine” is, as usual, totally wrong. And we’ll probably find that just a few days after this conference, it will be panic stations again in the European debt crisis.

BLODGET:You say you found Merkel’s speech concerning because of a commitment to austerity?

FERGUSON: Well, you see the problem is that the logic of what she said was that she sees Europe becoming like the Federal Republic of Europe over the next 20 years. The European Commission will be the government, Parliament will be more powerful, the Council of Ministers will be like the second chamber. Fine. But the Federal Republic of Germany isn’t based on an austerity pact that requires countries never to run a budget deficit. It’s based on a transfer union. The money goes from the richer Bavarians to the poorer north Germans and, of course, to the East Germans. And it’s based on a central treasury with things called Bunds. Now, if you apply the analogy to the European level, it means there has to be a proper European treasury and European bonds. And that’s just what the Germans have been opposing. So the German position is inconsistent. They want a Federal Europe, that’s now clear. But they’re not prepared to will the means. And you cannot base fiscal federalism exclusively on a pact—a kind of pact of death that nobody ever runs a budget deficit.

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